Claims that there has been a huge jump in structural unemployment — that is, unemployment that can’t be cured by increasing aggregate demand — are playing a large role in the argument that we should basically do nothing in the face of a terrible economy. No need for the Fed to do more; no need for more fiscal stimulus — hey, it’s all about defective labor markets, and we should work on structural reform, one of these days. And don’t expect improvement for years to come. Structural unemployment is invoked by Fed presidents who want to raise rates, not cut them, by economists who want austerity now now now, and in general by almost everyone in the pain caucus.
Legend aside, this is not mainly about displaced construction workers — and there are no other dying industries to point to. Lousy labor markets span the country, except in a handful of states with almost no people. It’s a terrible job situation for college graduates as well as high-school graduates.The idea that this economy is primarily suffering from mismatch is simply bizarre.
First let me say that I agree with Krugman in the essentials, but I find myself wondering if we can be confident that there really is not a larger structural problem embedded within the obvious acute problems of high unemployment and depressed aggregate demand? For example, suppose that there have been massive and pervasive distortions of human capital and labor and other markets resulting from massive distortions in or induced by financial markets. Suppose those distortions lasted at least 10 years and maybe a long as 30 years. Then many sectors of the economy and the workers in them have been shaped by the distortions in ways that may be difficult to discern.
The fact that the financial sector's share of GDP has grown so dramatically over the last 30 years suggests that other sectors have lost out in terms of the growth and productivity they might otherwise have delivered to the benefit of us all. A massive drain such as this must have affected both physical and human capital in those sectors as well as affecting the larger economy we would otherwise expect to see. Unfortunately, we have no way of knowing what is the conterfactual economy we would have observed without the bubble(s). (Note that if George Soros is correct and the last 30 years have been superbubble, then I think the effect I'm trying to describe is even more entrenched and difficult to detect.)
If my conjecture is right, might an economy, shaped by persistent and pervasive distortions in combination with a massive downturn and tightened credit, be characterized by no new and thriving sectors requiring new workers with new skills (because much of the capital that would have fueled them has been siphoned into contingent markets and housing) even as the existing sectors and workers languish? Could there be a larger structural problem, but we can't see it because the economy has been so distorted?
My point here is that Krugman is right (as usual) that there is no evidence consistent with structural unemployment, but are we missing something bigger? A perspective perhaps that would argue that we have something worse than short-term structural unemployment such as we might see in an economy characterized over the long-term by well-functioning markets and by rapid progress and growth, at least in some sectors other than finance. What if the misalignment is so long-standing and has been so destructive to real innovation and productivity that real growth and innovation have been effectively squelched in many sectors? Perhaps not everywhere and always, but enough that now when we look for signs of structural unemployment as Krugman has done, we find no indication of it because sectors where there might have been innovation and growth that would now be demanding workers with different skills, were not able to compete effectively for capital? As I write this, I think this can't really be possible. Even crippled markets would allocate some capital correctly, yes?
The beauty of capitalism and commercial exchange when they work is that they coordinate, communicate and equilibrate the demand for and supply of capital, human, financial, and physical, to those places where productivity is highest and output most valued. The false signals of bubbles do the exact opposite. Instead of producing growth in new technology, in new and better products, and in new jobs, our recent bubble most likely produced underinvestment in human and other forms of capital not directly beneficial to Wall Street along with immense amounts of unsecured risk, granite countertops and en suite baths.
I find myself asking, what would our and the world economy look like if Wall Street had been doing it's job? If I'm right, they would be dramatically different. In that case, as Krugman points out there is no mismatch between the jobs of that distorted economy and the skills of the workers who have been working in the economy that we have. If I'm right, the mismatch is between the workers of the economy we have and the workers of the economy we want and need to have to set us back on the counterfactual trajectory of more diverse growth and productivity; the counterfactual economy we would have had if Wall Street had been doing it's job. If I'm right then we have a major structural problem and I don't think anyone will be able to argue credibly that government should be shrunk and drowned in a bathtub. If it took years of misplaced private sector "enthusiasm" to create the misalignments, it will almost certainly require government to take a larger role in righting them. Thank you, Wall Street.
Let me make my case.
Earlier this year I observed that the price of casino-like finance is higher than we think. Specifically, not only did it siphon off trillions of dollars that created a surplus of homes and commercial real estate, not only did it siphon equity out of existing homes and transform it into bigger, more expensive cars and pickup trucks, and RVs, along with extra baths and state of the art kitchens that may or may not recoup value for homeowners, it also siphoned talent into the financial sector (and into the construction sector).
Now I’m going to ask you to imagine the counterfactual of the world in which the housing bubble occurred. Imagine that over the last 20 or so years our future mathematicians, social and physical scientists, and social workers had left undergraduate or graduate school in a world in which the financial sector had not become so large, so distorted by short-term private incentives, and therefore so personally lucrative. Moreover, imagine a world in which capital had not been siphoned to housing and real estate, but instead had been allocated (as we in the economics profession like to believe it will be) to those areas of the economy where potential returns to capital are highest, where technology is advancing (and presumably yielding benefit to us all). In the counterfactual world, the efficient allocation of capital would have blazed the efficient, productive trail into the steadily improving future we have for the most part observed since Adam Smith and others first noticed that the division of labor and the willingness of the owners of capital to seek its highest return appeared to take us all to something that was better than feudalism.
Now ask yourself: In that counterfactual world, where the financial sector was doing what it is supposed to do, what would the economy have looked like? Where would have been the jobs? How would individuals have adjusted their investment in human capital in order to increase their competitiveness for the counterfactual jobs? How would investors have invested? What would manufacturers have produced?
I believe that the answers to these questions tell us something about the nature of unemployment we are facing now and the policy options that are likely to drive us out of the (shallow thanks to the stimulus) unregulated-finance-sector-induced crater we find ourselves in.
The financial sector has muddied the waters for many years, not just the last quarter or two, signaling reductions in risk and returns to financial, physical and human capital that were highly distorted in many cases and that have consequently created large discontinuities in the demand for and supply of all types of capital and, consequently, in supply and demand in goods and services markets. The net effect in labor markets is that we now have a good match between skills and the jobs in the economy we used to have, but we may not have a good match between skills and jobs in the economy we could have had or the economy we would like to have. This is a structural problem, but not one that is likely to fix itself without some major restructuring in which the government and government policy must take active roles. Thank you, Wall Street.
If I'm right that we have a long-term structural problem, it will require remedies and restructuring that benefit more than the top 1% of wage earners. For this reason, shrinking government, while simultaneously refusing to stimulate aggregate demand, will almost certainly make the recession longer and deeper. On the other hand, stimulating aggregate demand in ways that preserve the old economy rather than reshaping it to produce the human and physical capital and public infrastructure that the counterfactual economy would have given us will only leave us mired in a dysfunctional economy.
Either way, when the private sector has been the problem, it's hard to imagine an effective solution that doesn't involve a safety net that includes health insurance combined with government action aimed at strategically boosting aggregate demand by targeting those most at risk and most likely to spend while also adopting public policies aimed at remedying the gross distortions in capital markets, human, physical, and financial, over the last 30 years.
Krugman's response, a clarification with which I am in full agreement, here.